The malaise in Britain’s corporate sector can be traced to policies and problems predating Conservative rule. But successive Tory administrations have been slow to stop the rot.
The UK stock market should be beacon of prosperity. Instead, it has struggled to foster and retain high-growth companies. The recent rally in London-listed equities doesn’t much change the big picture. The total return of the blue-chip FTSE 100 index has been well below the performance of its major peers in the last 14 years. As for FTSE 250 index, home to many UK-focused businesses, its price relative to overall earnings has barely budged. The rating of the US Russell 2000 of smaller US stocks was already higher in 2010 and has pulled further ahead.
The period of Conservative rule began amid a heated debate on the controversial US acquisition of Creme Egg confectioner Cadbury. But for most of the subsequent period, the government has batted away criticism of foreign takeovers by arguing they are a vote of confidence in Britain. The drain has continued. Months after the 2016 Brexit referendum triggered a slide in sterling, Japan’s SoftBank Group Corp. snapped up microchip designer Arm Holdings Plc. US buyout firms have feasted on cheap mid-sized UK stocks.
This “open” market is a good thing in many ways. The constant threat of a takeover is an essential spur to corporate performance. Well-resourced foreign buyers may be able to reenergize businesses that have drifted. But there are downsides when deals happen. Big decisions shift overseas. The role of the existing head office is diminished, affecting any UK firms that served it. It’s harder to shame foreign owners when things go wrong — a problem when the acquired company provides essential services.
This wouldn’t matter so much if the stock market was attracting plentiful high quality listings to replace the companies being bought. Yet the reverse is happening. Publicly traded firms have switched listing to New York from London, seeking higher valuations. Arm returned to the stock market last year, but in the US. With each departure, the average quality of the remaining listed companies diminishes absent a substitute stock offering. Attracting tomorrow’s winning businesses, and engaged investors, just gets harder.
Arguably, a key factor in all this is early-2000s regulation that applied new accounting to retirement plan valuations, incentivizing pension funds to shift to bonds from equities and directing UK companies to divert cash from investment to pension top-ups. Moreover, London has long been a stronghold for so-called income investors who favor companies that pay dividends over those that spend cash on investing to expand. The net effect is a stock market which no longer has a strong, supportive base of local investors and which is losing growth companies to rival bourses or bids.
True, credit is due for the many government reviews of the investment climate that have taken place since 2010. Yet these have had little concrete effect. Ministers have erred by allowing the environment to worsen.
Only lately has the Treasury mulled suitable remedies like spurring consolidation of the UK’s fragmented pensions sector into larger funds whose scale could support increased investment in riskier assets like equities. Ironically, this idea has been promoted by the institute of former premier Tony Blair — a tacit acknowledgement of past Labour policy mistakes and the need to address them.
Creative thinking is needed. London-based think tank Turning the Page has advocated selling the state’s stake in NatWest Group Plc and reinvesting the proceeds in a sovereign wealth fund seeded with small and mid-sized UK stocks. It also proposes making certain pension tax breaks contingent on partial allocation of fund assets to the UK, effectively limiting taxpayer subsidy for buying overseas stocks. These make sense.
But the greatest need is to reinvigorate long-term UK investment. Consultation is already underway on tax breaks for retail saving via UK stocks. Mandating much higher employer pension contributions, with a portion compulsorily invested at home, could go further. Such a policy would, of course, add a near-term burden on the corporate sector. Pension fund managers also balk at the slightest suggestion of any constraint on investment allocations. The fact is there are no-cost free solutions here.
Failing to act now will just store up future costs in weak growth and higher taxation, Turning the Page argues. Given the difficult compromises that need to be struck, governments have dithered over substantial reform. There have been enough reviews. The next administration must do what it takes to rebuild the domestic reservoir of investment capital on which the UK corporate sector depends.
Bloomberg
